Growth economics and development economics

Development economics may be contrasted with another branch of study, called growth
economics, which is concerned with the study of the long-run, or steady-state, equilibrium
growth paths of the economically developed countries, which have long overcome the problem
of initiating development.

Growth theory assumes the existence of a fully developed modern capitalist economy with a
sufficient supply of entrepreneurs responding to a well-articulated system of economic
incentives to drive the growth mechanism. Typically, it concentrates on macroeconomic
relations, particularly the ratio of savings to total output and the aggregate capital–output ratio
(that is, the number of units of additional capital required to produce an additional unit of output).
Mathematically, this can be expressed (the Harrod–Domar growth equation) as follows: the
growth in total output (g) will be equal to the savings ratio (s) divided by the capital–output ratio
Thus, suppose that 12 percent of total output is saved annually and that three units of capital
are required to produce an additional unit of output: then the rate of growth in output is
12
/
3
% = 4% per annum. This result is obtained from the basic assumption that whatever is saved
will be automatically invested and converted into an increase in output on the basis of a given
capital–output ratio. Since a given proportion of this increase in output will be saved and
invested on the same basis, a continuous process of growth is maintained.

Growth theory, particularly the Harrod–Domar growth equation, has been frequently applied or
misapplied to the economic planning of a developing country. The planner starts from a desired
target rate of growth of perhaps 4 percent. Assuming a fixed overall capital–output ratio of, say,
3, it is then asserted that the developing country will be able to achieve this target rate of growth
if it can increase its savings to 3 × 4 percent = 12 percent of its total output. The weakness of
this type of exercise arises from the assumption of a fixed overall capital–output ratio, which
assumes away all the vital problems affecting the developing country’s capacity to absorb
capital and invest its savings in a productive manner. These problems include the central
problem of the efficient allocation of available savings among alternative investment
opportunities and the associated organizational and institutional problems of encouraging the
growth of a sufficient supply of entrepreneurs; the provision of appropriate economic incentives
through a market system that correctly reflects the relative scarcities of products and factors of
production; and the building up of an organizational framework that can effectively implement
investment decisions in both the private and the public sectors. Such problems, which generally
affect the developing country’s absorptive capacity for capital and a number of other inputs,
constitute the core of development economics. Development economics is needed precisely
because the assumptions of growth economics, based as they are on the existence of a fully
developed and well-functioning modern capitalist economy, do not apply.
The developing and underdeveloped countries are a very mixed collection of countries. They
differ widely in area, population density, and natural resources. They are also at different stages
in the development of market and financial institutions and of an effective administrative
framework. These differences are sufficient to warn against wide-sweeping generalizations
about the causes of underdevelopment and all-embracing theoretical models of economic
development. But when development economics first came into prominence in the 1950s, there
were powerful intellectual and political forces propelling the subject toward such general
theoretical models of development and underdevelopment. First, many writers who popularized
the subject were frankly motivated by a desire to persuade the developed countries to give more
economic aid to the underdeveloped countries, on grounds ranging from humanitarian
considerations to considerations of cold-war strategy. Second, there was the reaction of the
newly independent underdeveloped countries against their past “colonial economic pattern,”
which they identified with free trade and primary production for the export market. These
countries were eager to accept general theories of economic development that provided a
rationalization for their deep-seated desire for rapid industrialization. Third, there was a parallel
reaction, at the academic level, against older economic theory, with its emphasis on the efficient
allocation of scarce resources and a striving after new and “dynamic” approaches to economic
development.

All of these forces combined to produce a crop of theoretical approaches that soon developed
into a fairly fixed orthodoxy with its characteristic emphasis on “crash” programs of investment in
both material and human capital, on domestic industrialization, and on government economic
planning as the standard ingredients of development policy. These new theories have continued
to have a considerable influence on the conventional wisdom in development economics,
although in retrospect most of them have turned out to be partial theories. A broad survey of
these theories, under three main heads, is given below. It is particularly relevant to the debate
over whether the underdeveloped countries should seek economic development through
domestic industrialization or through international trade. The limitations of these new
theories—and how they led to a gradual revival of a more pragmatic approach to development
problems, which falls back increasingly on the older economic theory of efficient allocation of
resources—are subsequently traced.

The missing-component approach

First, there are theories that regard the shortage of some strategic input (such as the supply of
savings, foreign exchange, or technical skills) as the main cause of underdevelopment. Once
this missing component was supplied—say, by external economic aid—it was believed that
economic development would follow in a predictable manner based on fixed quantitative
relationships between input and output. The overall capital–output ratio, mentioned above, is the
most well-known of these fixed technical coefficients. But similar fixed coefficients have been
assumed between the foreign-exchange requirements and total output and between the input of
skilled manpower and output.